The Pay Czar's Diversion

Ninety-four percent of college professors believe they are above average teachers, and 90 percent of drivers believe they are above average behind the wheel. Researchers Paul J.H. Schoemaker and J. Edward Russo gave computer executives quizzes on their industry. Afterward, the executives estimated that they had gotten 5 percent of the answers wrong. In fact, they had gotten 80 percent of the answers wrong.

Since the masters of finance have been exposed as idiots, the masters of government have concluded (somewhat illogically) that they must be really smart.

He goes on to suggest that the actions of the pay czar in regulating bonuses reflect the "fatal conceit" (a title of one of Hayek's works) of government officials thinking that they have wisdom that private actos lack.

I think there is something even more sinister going on. I interpret the pay czar in terms of Murray Edelman's symbolic uses of politics. The idea is to focus on a symbol of the cause of taxpayer losses--bonuses of the executives of bailed out firms--in order to distract attention from the substance. The substantive issue is the extent to which the losses were caused by political actions and the extent to which they are concentrated at Freddie Mac and Fannie Mae.

Back in 2007, when this was called "the subprime crisis," I wrote that Freddie and Fannie would be nearly unscathed, and that this was entirely a Wall Street problem. I am not sure if I wrote this on my blog, but I did write in a chapter of the forthcoming From Poverty to Prosperity (with Nick Schulz) that none of the major regulated institutions was involved in subprime. As the book was being edited for publication, I discreetly removed that paragraph.

The further into this crisis we go, the greater the share of subprime loans and mortgage losses are turning out to be located at Freddie and Fannie. Even one year ago, if you had asked me, I would have told you to expect at least 2/3 of the losses to be at companies like Citi and Bear, with less than 1/3 at Freddie and Fannie. It now looks quite different. Conservatively, 3/4 of taxpayers losses will be at Freddie and Fannie. Perhaps as much as 90 percent of taxpayer losses will be there.

Given the large role of Freddie and Fannie, it makes sense for politicians to create as large a diversion as possible. Hence, the brouhaha over bonuses at bailed-out banks.

Incidentally, the debate over the "public option" in health reform also can be viewed as an exercise in symbolic politics and diversion. The point is to divert attention away from the bankruptcy of Medicare.

Comments and Sharing

This is tangential, but the factoid that most drivers believe they are better than average has always struck me as a poor illustration of self-deception. Not all phenomena are normally distributed. I would venture that, based on metrics like traffic fines and accidents, a large majority of drivers *are* better than average, so long as we don't confuse the average with the median.

Futhermore, drivers have different ideas about what constitutes goodness; it can easily be correct that each driver's position by his metric really is above average. Driver A might prize adherence to all traffic rules and follow them better than others while driver B might prize speed and be faster than others.

Re: CEOs and 5 percent right

Well, it's trivial to construct a test which is essentially a set of traps or is nit-pickingly literal ("Aha! At that time, the official company name was not 'XYZ Corp.' but 'XYZ Inc.'!"). Without seeing the test and both the CEOs' answers and the official answers, I have no way of knowing whether the quoted result is significant or a cheap shot. Given the huge disparity between the estimated 80% correct and the actual 5% correct, I strongly suspect a cheap shot.

One quick question: where are you getting the data for which loans are losing money? It'd be helpful for all of us who've been following the discussion to have some sources for raw data.
Thanks and kudos on your illuminating take on the crisis.

How can one use Economics to predict an economic outcome when politicians will always step in?

http://econlog.econlib.org/archives/2009/05/exactly_wrong_t.html
Here is a Caplan post from May, arguing a truly economic position about credit cards and risky borrowers. My comment was, the economics is irrelevant if Congress will keep changing the rules to get the outcome they want.

Any economic theory that makes no accommodation for Congress is wrong. I see the financial crisis as a purely political crisis. The economics, such as it is, is an amplifier. We will never get to the fix we need, i.e. less government, when politicians can protect their own interests so powerfully.

The percentage of overall loses attributed to Fannie and Freddie is amazing. I would greatly appreciate a link to this information. How does an economic system exist when real value is consistently masked and distorted?

I never said I had hard data on taxpayer losses. A major objective of government is to obfuscate and hide that data.

I am just trying to adjust to reports like this:
http://www.economist.com/businessfinance/displaystory.cfm?story_id=14214879

I am guessing that the taxpayer losses for all other bailouts will be about $30 billion, and from what I read, the low end of the estimates for Fannie and Freddie are $100 billion, and the high end (Charles Calomiris) is $350 billion. That's how I arrive at the guesses I put into my post.

Again, I admit that it's really hard to get a handle on the losses, particularly at banks and AIG. The Fed is holding a lot of stuff that is not being marked to market. I would not presume to know how to account for the "profits" earned by companies that borrow at government-subsidized rates to take on new business. If the TARP inspector says that the process is opaque, far be it from me to suggest that I have exact numbers.

SydB: "The problem with the above argument: it argues against any effort by management or those in charge (in any sense) to review and reward those working for them. Which of course is how capitalism works."

You have to account for how far management (regulators) are from the shop floor. Talk to anyone who works in a remote field office of a large company and you will hear hours of stories about asinine policy directives from the home office.

Low-level regulators are often quite close to the thing they regulate. FAA inspectors spend a lot of time in maintenance hangars, and a friend of mine who works in the fisheries division at NOAA is out on a boat at least once a month during the season. These folks also tend to complain a lot about what the guys in DC say they're supposed to do.

Syd: I'd wager that unearned grandiosity causes at least as many failures as succeses. Many interesting new businesses fail because their big idea isn't quite aligned with what customers want.

The problem with regulation is that there's no natural pruning mechanism. Companies which choose badly suffer market discipline. Microsoft couldn't force us to live with Windows Vista and they are more of a monopolist than anything short of a utility company. Regulations however are like Molly bolts: a lit easier to install than remove. Ineffective regulations become entrenched simply by existing. Personally I would trade most of the Constitution for a single clause that said that every law expired after five years.

Regarding your aside about the public option being a diversion.I agree it is a diversion but also I think it is a diversion from discussion about the personal and employee mandates.I agree with Michael Cannon,from Cato,it is not the public option that constitutes a government take over but the mandates.See Chttp://www.cato.org/pub_display.php?pub_id=10576ato briefing paper#114,"All the President's mandates.Compulsory health insurance is a government take over"

I wonder if David Brooks or Arnold Kling is as smart as he thinks he is. At least they have the humility to not broadcast their opinions to the world as if they're especially insightful... wait a second.

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